In general, a firm can best protect itself by having a written policy that clearly spells out the firms vacation/PTO program and maintaining the records to support the program in strict conformance with that written policy.

Importance of Records

In California, a professional services firm was sued by its former controller for unused vacation time not paid by the firm on his last day of employment. The firm maintained a written policy that stated clearly that nobody could accrue more than 25 days of vacation time. While finalizing his separation paperwork, the controller claimed that he was owed 35 days of vacation pay. Neither the HR department nor the finance department maintained a current record of each employees unused vacation time balance that should have been capped at the 25-day level in support of the policy.

Instead, when an employee left the firm, the HR department manually counted the number of vacation days the employee reported on a special vacation authorization form and subtracted that from the total number of days the person had earned during his or her employment period; if employees ended up being owed more than 25 days when they left the firm, they were paid 25 days in conformance with the written policy. On the surface, management believed this policy and practice to be prudent. However, in this case, the former controller maintained his own records, which showed that he was owed 35 days.

The Labor Commission ruled against the firm and ordered it to pay not only the additional 10 days of vacation but also an additional months salary plus interest because the full payment was not made on the employees last day of employment even though the ruling was issued a year after he left the firm. The Commission ruled against the firm primarily because the firm did not maintain a vacation tracking system that clearly computed the actual vacation balance at any point in time and mechanically capped that accrual amount once the limit was reached. In this case, the person who arguably should have been responsible for ensuring that proper records were kept by the firm was able to legally profit from his own mismanagement.

Accounting

Accounting in a professional services firm should be among the least complicated in our economy. The firm bills its clients for services rendered, the client pays the invoice, and the firm pays its employees, landlord, and other overhead suppliers. Thats about as simple as can be expected in a business. However, once the firm begins to enter into complicated client compensation

agreements, complex vendor contracts, and spend its clients money with the understanding it will be reimbursed for its outlays, the accounting issues and risks to the firms financial statements begin to multiply.

Management of the financial records is the responsibility of not only the CFO but also the board, CEO, COO, department heads, managers, and supervisors. Each of those managers is responsible for ensuring the integrity of his or her respective areas revenues, expenses, assets, and liabilities. This section reviews key accounting issues of which the senior executive should be aware. Our discussion generally centers on corporate structures, but also are, for the most part, applicable to partnerships and Subchapter S corporations that may rely on the cash basis of accounting.

Fundamental Accounting Concepts

The most basic checkbook accounting system tracks total deposits and total withdrawals. If your deposits are greater than your withdrawals during a specific period of time, you made money, but were you profitable? Maybe yes and maybe no.

The answer to that question lies in the definition of the word profit. For hundreds of years, accountants have worked to develop a standard set of rules to follow to determine whether a firm was in fact profitable during a specific period of time. Those rules, which are continuously being refined over time, are referred to in the United States as generally accepted accounting principles (GAAP). These principles are a collection of theories, rules, pronouncements, and writings that have evolved over time to meet not only the general needs of investors and managers but also specific issues faced by each industry. Although most accounting principles have been published in any of a number of authoritative publications, no single list of all GAAP exists. Rather, they reflect the cumulative consensus of industry conventions, current writings, and pronouncements on any particular accounting issue.

GAAP, in their simplest form, adhere to a set of about a dozen foundational principles that guide the formation of all other rules. Today these principles are even more rigorously applied in the audit process in response to Sarbanes-Oxley and other related legislative and regulatory actions. Key principles that professional services firm executives should understand include:

Revenue realization: Revenue should be recognized when it is earned, not necessarily when an agreement is made or cash is received.

Cost: Assets and liabilities generally should be recorded at their historical cost and expensed during the period to which they pertain.

Matching: The matching principle guides timing of the recognition of revenues and expenses and seeks to ensure that revenues are recognized in the same time period costs related thereto are expensed. For example,

if salaries are paid to work on consulting projects during a year, the net realizable value of those services should be, in general, recognized as revenue during that same period even though cash for those services may not be received until the subsequent year.

Objectivity: Revenues, expenses, assets, and liabilities should be booked at values that can be established through objective evidence. Documentation supporting any value used in the accounting records should be maintained and made available to authorized third parties to verify (e.g., tax authorities, auditors, investors).

Consistency: Financial statements should be prepared on a consistent basis from period to period using similar methodologies in order to yield meaningful comparisons among time periods.

Disclosure: Financial statements should be complete in disclosing to investors and managers all pertinent information to ensure that the statements by themselves are not misleading. Explanatory notes normally are included with financial statements and are intended to supplement the numbers presented to ensure that the complete package presents fairly critical information to prevent the statements from being misleading. Such disclosures include: changes of accounting methods, summary of significant accounting policies, descriptions of lease and other long-term debt obligations, stock option plans, and significant subsequent events.

Materiality: Accounting principles recognize that it may be impractical to account for all transactions in the same theoretically correct manner; thus, immaterial transactions do not necessarily need to be accounted for in a manner consistent with larger transactions. This is particularly true if the cost of doing so exceeds the value of reflecting the transaction in the theoretically correct manner. For example, a $500 chair may have a useful life of 10 years or more, but the cost of capitalizing that asset and depreciating it over 10 years would far outweigh the cost of expensing it in the period it was purchased.

Conservatism: In preparing financial statements, many assumptions and estimates are made in order to present fairly the full financial position of the firm. When a reasonable basis exists for two or more different estimates or values to be used for a particular item in the financials, the one that shows the least favorable effect on the firm in the current period should be selected. By selecting the least favorable method, management enhances the quality of the earnings reported, which, over time, can strengthen both the firms credibility and its relative financial position.

In summary, GAAP are the set of rules to be followed in the preparation of all financial statements, and these general principles form the basis of all other accounting concepts and practices. Other key concepts and issues of which professional firm executives should be aware include: